It’s two years since Russia invaded Ukraine. Western countries responded by imposing large-scale sanctions. These targeted a range of businesses, banks and other financial institutions, payments systems and Russian exports and imports. Some $1 trillion of Russian assets were frozen. Many Western businesses withdrew from Russia or cut off commercial ties. In addition, oil and gas imports from Russia have been banned by most developed countries and some developing countries, and a price cap of $60 per barrel has been imposed on Russian oil. What is more, sanctions have been progressively tightened over the past two years. For example, on the second anniversary of the invasion, President Biden announced more than 500 new sanctions against individuals and companies involved in military production and supply chains and in financing Russia’s war effort.
The economy in Russia has also been affected by large-scale emigration of skilled workers, the diversion of workers to the armed forces and the diversion of capital and workers to the armaments industry.
So has the economy of Russia been badly affected by sanctions and these other factors? The IMF in its World Economic Forecast of April 2022 predicted that the Russian economy would experience a steep, two-year recession. But, the Russian economy has fared much better than first predicted and the steep recession never materialised.
In this blog we look at Russia’s economic performance. First, we examine why the Russian economy seems stronger today than forecast two years ago. Then we look at its economic weaknesses directly attributable to the war.
Apparent resilience of the Russian economy
GDP forecasts have proved wrong. In April 2022, just after the start of the war, the IMF was forecasting that the Russian economy would decline by 8.5% in 2022 and by 2.3% in 2023 and grow by just 1.5% in 2024. In practice, the economy declined by only 1.2% in 2022 and grew by 3.0% in 2023. It is forecast by the IMF to grow by 2.6% in 2024. This is illustrated in the chart (click here for a PowerPoint).
Similarly, inflation forecasts have proved wrong. In April 2022, Russian consumer price inflation was forecast to be 21.3% in 2022 and 14.3% in 2023. In practice, inflation was 13.8% in 2022 and 7.4% in 2023. What is more, consumer spending in Russia has remained buoyant. In 2023, retail sales rose by 10.2% in nominal terms – a real rise of 2.8%. Wage growth has been strong and unemployment has remained low, falling from just over 4% in February 2022 to just under 3% today.
So why has the Russian economy seemingly weathered the war so successfully?
The first reason is that, unlike Ukraine, very little of its infrastructure has been destroyed. Even though it has lost a lot of its military capital, including 1120 main battle tanks and some 2000 other armoured vehicles, virtually all of its production capacity remains intact. What is more, military production is replacing much of the destroyed vehicles and equipment.
The second is that its economy started the war in a strong position economically. In 2021, it had a surplus on the current account of its balance of payments of 6.7% of GDP, reflecting large revenues from oil, gas and mineral exports. This compares with a G7 average deficit of 0.7%. It had fiscal surplus (net general government lending) of 0.8% of GDP. The G7 countries had an average deficit of 9.1% of GDP. Its gross general government debt was 16% of GDP. The G7’s was an average of 134%. This put Russia in a position to finance the war and gave it a considerable buffer against economic sanctions.
The third reason is that Russia has been effective in switching the destinations of exports and sources of imports. Trade with the West, Japan and South Korea has declined, but trade with China and various neutral countries, such as India have rapidly increased. Take the case of oil: in 2021, Russia exported 4.4 billion barrels of oil per day to the USA, the EU, the UK, Japan and South Korea. By 2023, this had fallen to just 0.6 billion barrels. By contrast, in 2021, it exported 1.9 billion barrels per day to China, India and Turkey. By 2023, this had risen to 4.9 billion. Although exports of natural gas have fallen by around 42% since 2021, Russian oil exports have remained much the same at around 7.4 million barrels per day (until a voluntary cut of 0.5 billion barrels per day in 2024 Q1 as part of an OPEC+ agreement to prop up the price of oil).
China is now a major supplier to Russia of components (some with military uses), commercial vehicles and consumer products (such as cars and electrical goods). Total trade with China (both imports and exports) was worth $147 billion in 2021. By 2023, this had risen to $240 billion.
The use of both the Chinese yuan and the Russian rouble (or ruble) has risen dramatically as a means of payment for Russian imports. Their share has risen from around 5% in 2021 (mainly roubles) to nearly 75% in 2023 (just over 37% in each currency). Switching trade and payment methods has helped Russia to circumvent many of the sanctions.
The fourth reason is that Russia has a strong and effective central bank. It has successfully used interest rates to control inflation, which is expected to fall from 7.4% in 2023 to under 5% this year and then to its target of 4% in subsequent years. The central bank policy rate was raised from 8.5% to 20% in February 2022. It then fell in steps to 7.5% in September 2022, where it remained until August 2023. It was then raised in steps to peak at 16% in December 2023, where it remains. There is a high level of confidence that the Russian central bank will succeed in bringing inflation back to target.
The fifth reason is that the war has provided a Keynesian stimulus to the economy. Military expenditure has doubled as a share of GDP – from 3.7% of GDP in 2021 to 7.5% in 2024. It now accounts for around 40% of government expenditure. The boost that this has given to production and employment has helped achieve the 3% growth rate in 2023, despite the dampening effect of a tight monetary policy.
Longer-term weaknesses
Despite the apparent resilience of the economy, there are serious weaknesses that are likely to have serious long-term effects.
There has been a huge decline in the labour supply as many skilled and professional workers have move abroad to escape the draft and as many people have been killed in battle. The shortage of workers has led to a rise in wages. This has been accompanied by a decline in labour productivity, which is estimated to have been around 3.6% in 2023.
Higher wages and lower productivity is putting a squeeze on firms’ profits. This is being exacerbated by higher taxes on firms to help fund the war. Lower profit reduces investment and is likely to have further detrimental effects on labour productivity.
Although Russia has managed to circumvent many of the sanctions, they have still had a significant effect on the supply of goods and components from the West. As sanctions are tightened further, so this is likely to have a direct effect on production and living standards. Although GDP is growing, non-military production is declining.
The public finances at the start of the war, as we saw above, were strong. But the war effort has turned a budget surplus of 0.8% of GDP in 2021 to a deficit of 3.7% in 2023 – a deficit that will be difficult to fund with limited access to foreign finance and with domestic interest rates at 16%. As public expenditure on the military has increased, civilian expenditure has decreased. Benefits and expenditure on infrastructure are being squeezed. For example, public utilities and apartment blocks are deteriorating badly. This has a direct on living standards.
In terms of exports, although by diverting oil exports to China, India and other neutral countries Russia has manage to maintain the volume of its oil exports, revenue from them is declining. Oil prices have fallen from a peak of $125 per barrel in June 2022 to around $80 today. Production from the Arabian Gulf is likely to increase over the coming months, which will further depress oil prices.
Conclusions
With the war sustaining the Russian economy, it would be a problem for Russia if the war ended. If Russia won by taking more territory in Ukraine and forcing Ukraine to accept Russia’s terms for peace, the cost to Russia of rebuilding the occupied territories would be huge. If Russia lost territory and negotiated a settlement on Ukraine’s terms, the political cost would be huge, with a disillusioned Russian people facing reduced living standards that could lead to the overthrow of Putin. As The Conversation article linked below states:
A protracted stalemate might be the only solution for Russia to avoid total economic collapse. Having transformed the little industry it had to focus on the war effort, and with a labour shortage problem worsened by hundreds of thousands of war casualties and a massive brain drain, the country would struggle to find a new direction.
Articles
- How Russia’s economy survived two years of war
The Bell (23/2/24)
- How Russia uses China to get round sanctions
The Bell, Denis Kasyanchuk (20/2/24)
- As Ukraine’s economy burns, Russia clings to a semblance of prosperity
The Observer, Larry Elliott and Phillip Inman (24/2/24)
- ‘A lot higher than we expected’: Russian arms production worries Europe’s war planners
The Guardian, Andrew Roth (15/2/24)
- There are lessons from Russia’s GDP growth — but not the ones Putin thinks
Financial Times, Martin Sandbu (11/2/24)
Russia’s economy going strongDW, Miltiades Schmidt (21/2/24)
- The West tried to crush Russia’s economy. Why hasn’t it worked?
Politico, Nahal Toosi, Ari Hawkins, Koen Verhelst, Gabriel Gavin and Kyle Duggan (24/2/24)
- Don’t Buy Putin’s Bluff. The West Can Outspend Him.
Bloomberg UK, Editorial (23/2/24)
- Russia’s war economy cannot last but has bought time
BBC News, Faisal Islam (11/2/24)
- US targets Russia with more than 500 new sanctions
BBC News, George Wright and Will Vernon (24/2/24)
- Russia’s economy is now completely driven by the war in Ukraine – it cannot afford to lose, but nor can it afford to win
The Conversation, Renaud Foucart (22/2/24)
Questions
- Argue the case for and against including military production in GDP.
- How successful has the freezing of Russian assets been?
- How could Western sanctions against Russia be made more effective?
- What are the dangers to Western economies of further tightening financial sanctions against Russia?
- Would it be a desirable policy for a Western economy to divert large amounts of resources to building public infrastructure?
- Has the Ukraine war hastened the rise of the Chinese yuan as a reserve currency?
- How would you summarise Russia’s current public finances?
- How would you set about estimating the cost to Russia of its war with Ukraine?
World politicians, business leaders, charities and pressure groups are meeting in Davos at the 2022 World Economic Forum. Normally this event takes place in January each year, but it was postponed to this May because of Covid-19 and is the first face-to-face meeting since January 2020.
The meeting takes place amid a series of crises facing the world economy. The IMF’s Managing Director, Kristalina Georgieva, described the current situation as a ‘confluence of calamities’. Problems include:
- Continuing hangovers from Covid have caused economic difficulties in many countries.
- The bounceback from Covid has led to demand outpacing supply. The world is suffering from a range of supply-chain problems and shortages of key materials and components, such as computer chips.
- The war in Ukraine has not only caused suffering in Ukraine itself, but has led to huge energy and food price increases as a result of sanctions and the difficulties in exporting wheat, sunflower oil and other foodstuffs.
- Supply shocks have led to rising global inflation. This will feed into higher inflationary expectations, which will compound the problem if they result in higher prices and wages in response to higher costs.
- Central banks have responded by raising interest rates. These dampen an already weakened global economy and could push the world into recession.
- Global inequality is rising rapidly, both within countries and between countries, as Covid disruptions and higher food and energy prices hit the poor disproportionately. Poor people and countries also have a higher proportion of debt and are thus hit especially hard by higher interest rates.
- Global warming is having increasing effects, with a growing incidence of floods, droughts and hurricanes. These lead to crop failures and the displacement of people.
- Countries are increasingly resorting to trade restrictions as they seek to protect their own economies. These slow economic growth.
World leaders at Davos will be debating what can be done. One approach is to use fiscal policy. Indeed, Kristalina Georgieva said that her ‘main message is to recognise that the world must spend the billions necessary to contain Covid in order to gain trillions in output as a result’. But unless the increased expenditure is aimed specifically at tackling supply shortages and bottlenecks, it could simply add to rising inflation. Increasing aggregate demand in the context of supply shortages is not the solution.
In the long run, supply bottlenecks can be overcome with appropriate investment. This may require both greater globalisation and greater localisation, with investment in supply chains that use both local and international sources.
International sources can be widened with greater investment in manufacturing in some of the poorer developing countries. This would also help to tackle global inequality. Greater localisation for some inputs, especially heavier or more bulky ones, would help to reduce transport costs and the consumption of fuel.
With severe supply shocks, there are no simple solutions. With less supply, the world produces less and becomes poorer – at least temporarily until supply can increase again.
Articles
Discussion (video)
Report
Questions
- Draw an aggregate demand and supply diagram (AD/AS or DAD/DAS) to illustrate the effect of a supply shock on output and prices.
- Give some examples of supply-side policies that could help in the current situation.
- What are the arguments for and against countries using protectionist policies at the current time?
- What policies could countries adopt to alleviate rapid rises in the cost of living for people on low incomes? What problems do these policies pose?
- What are the arguments for and against imposing a windfall tax on energy companies and using the money to support poor people?
- If the world slips into recession, should central banks and governments use expansionary monetary and fiscal policies?
Global oil prices (Brent crude) reached $128 per barrel on 9 March, a level not seen for 10 years and surpassed only in the run up to the financial crisis in 2008. Oil prices are determined by global demand and supply, and the current surge in prices is no exception.
A rise in demand and/or a fall in supply will lead to a rise in the price. Given that both demand and supply are relatively price inelastic, such shifts can cause large rises in oil prices. Similarly, a fall in demand or rise in supply can lead to a large fall in oil prices.
These changes are then amplified by speculation. Traders try to get ahead of price changes. If people anticipate that oil prices will rise, they will buy now, or make a contract to buy more in the future at prices quoted today by buying on the oil futures market. This then pushes up both spot (current) prices and futures prices. If demand or supply conditions change, speculation will amplify the reaction to such a change.
What has happened since 2019?
In 2019, oil was typically trading at around $60 to $70 per barrel. It then fell dramatically in early 2020 as the onset of COVID-19 led to a collapse in demand, for both transport and industry. The price fell below $20 in late April (see charts: click here for a PowerPoint).
Oil prices then rose rapidly as demand recovered somewhat but supply chains, especially shipping, were suffering disruptions. By mid-2021, oil was once more trading at around $60 to $70 per barrel. But then demand grew more strongly as economic recovery from COVID accelerated. But supply could not grow so quickly. By January 2022, Brent crude had risen above $80 per barrel.
Then worries began to grow about Russian intentions over Ukraine as Russia embarked on large-scale military exercises close to the border with Ukraine. People increasingly disbelieved Russia’s declarations that it had no intention to invade. Russia is the world’s second biggest producer of oil and people feared that deliberate disruptions to supply by Russia or other countries banning imports of Russian oil would cause supply shortages. Speculation thus drove up the oil price. By 23 February, the day before the Russian invasion of Ukraine, Brent crude had risen to $95.
With the Russian invasion, moves were made by the EU the USA and other countries to ban or limit the purchase of Russian oil. This increased the demand for non-Russian oil.
On 8 March, the USA announced that it was banning the import of Russian oil with immediate effect. The same day, the UK announced that it would phase out the import of Russian oil and oil products by the end of 2022.
The EU is much more dependent on Russian oil imports, which account for around 27% of EU oil consumption and 2/3 of extra-EU oil imports. Nevertheless, it announced that it would accelerate the move away from Russian oil and gas and towards green alternatives. By 8 March, Brent crude had risen to $128 per barrel.
The question was then whether other sources of supply would help to fill the gap. Initially it seemed that OPEC+ (excluding Russia) would not increase production beyond the quotas previously agreed by the cartel to meet recovery in world demand. But then, on 9 March, the UAE Ambassador to Washington announced that the county favoured production increases and would encourage other OPEC members to follow suit. With the announcement, the oil price fell by 11% to £111. But the next day, it rose again somewhat as the UAE seemed to backtrack, but then fell back slightly as OPEC said there was no shortage of oil.
This is obviously an unfolding story with the suffering of the Ukrainian people at its heart. But the concepts of supply and demand and their price elasticity and the role of speculation are central to understanding what will happen to oil prices in the coming months with all the consequences for poverty and economic hardship.
Articles
Data
Questions
- Use a demand and supply diagram to illustrate what has happened to oil prices over the past two years. How has the size of the effects been dependent on the price elasticity of demand for oil and the price elasticity of supply of oil?
- Use a demand and supply diagram to show what has been happening to the price of natural gas over the past two years. Are the determinants similar to those in the oil market? How do they differ (if at all)?
- What policy options are open to governments to deal with soaring energy prices?
- What are the distributional consequences of the rise in energy prices? (see the blog: Rise in the cost of living.)
- Under what circumstances are oil prices over the next six months likely (a) fall; (b) continue rising?
The suffering inflicted on the Ukrainian people by the Russian invasion is immense. But, at a much lower level, the war will also inflict costs on people in countries around the world. There will be significant costs to households in the form of even higher energy and food price inflation and a possible economic slowdown. The reactions of governments and central banks could put a further squeeze on living standards. Stock markets could fall further and investment could decline as firms lose confidence.
Russia is the world’s second largest oil supplier and any disruption to supplies will drive up the price of oil significantly. Ahead of the invasion, oil prices were rising. At the beginning of February, Brent crude was around $90 per barrel. With the invasion, it rose above $100 per barrel.
Russia is also a major producer of natural gas. The EU is particularly dependent on Russia, which supplies 40% of its natural gas. With Germany halting approval of the major new gas pipeline under the Baltic from Russia to Germany, Nord Stream 2, the price of gas has rocketed. On the day of the invasion, European gas prices rose by over 50%.
Nevertheless, with the USA deciding not to extend sanctions to Russia’s energy sector, the price of gas fell back by 32% the next day. It remains to be seen just how much the supplies of oil and gas from Russia will be disrupted over the coming weeks.
Both Russia and Ukraine are major suppliers of wheat and maize, between them responsible for 14% of global wheat production and 30% of global wheat exports. A significant rise in the price of wheat and other grains will exacerbate the current rise in food price inflation.
Russia is also a significant supplier of metals, such as copper, platinum, aluminium and nickel, which are used in a wide variety of products. A rise in their price has begun and will further add to inflationary pressures and supply-chain problems which have followed the pandemic.
The effect of these supply shocks can be illustrated in a simple aggregate demand and supply diagram (see Figure 1), which shows a representative economy that imports energy, grain and other resources. Aggregate demand and short-run aggregate supply are initially given by AD0 and SRAS0. Equilibrium is at point a, with real national income (real GDP) of Y0 and a price index of P0.
The supply shock shifts short-run aggregate supply to SRAS1. Equilibrium moves to point b. The price index rises to P1 and real national income falls to Y1. If it is a ‘one-off’ cost increase, then the price index will settle at the new higher level and GDP at the new lower level provided that real aggregate demand remains the same. Inflation will be temporary. If, however, the SRAS curve continues to shift upwards to the left, then cost-push inflation will continue.
These supply-side shocks make the resulting inflation hard for policymakers to deal with. When the problem lies on the demand side, where the inflation is accompanied by an unsustainable boom, a contractionary fiscal and monetary policy can stabilise the economy and reduce inflation. But the inflationary problem today is not demand-pull inflation; it’s cost-push inflation. Disruptions to supply are both driving up prices and causing an economic slowdown – a situation of ‘stagflation’, or even an inflationary recession.
An expansionary policy, such as increasing bond purchases (quantitative easing) or increasing government spending, may help to avoid recession (at least temporarily), but will only exacerbate inflation. In Figure 2, aggregate demand shifts to AD2. Equilibrium moves to point c. Real GDP returns to Y0 (at least temporarily) but the price level rises further, to P2. (Click here for a PowerPoint of the diagram.)
A contractionary policy, such as raising interest rates or taxes, may help to reduce inflation but will make the slowdown worse and could lead to recession. In the diagram, aggregate demand shifts to AD3. Equilibrium moves to point d. The price level returns to P0 (at least temporarily) but real income falls further, to Y3.
In other words, you cannot tackle both the slowdown/recession and the inflation simultaneously by the use of demand-side policy. One requires an expansionary fiscal and/or monetary policy; the other requires fiscal and/or monetary tightening.
Then there are other likely economic stresses. If NATO countries respond by increasing defence expenditure, this will put further strain on public finances.
Sentiment is a key driver of the economy and prices. Expectations tend to be self-fulfilling. So if the war in Ukraine undermines confidence in stock markets and the real economy and further raises inflationary expectations, this pessimistic mood will tend in itself to drive down share prices, drive up inflation and drive down investment and economic growth.
Articles
- How will Russia’s invasion of Ukraine hit the global economy?
Financial Times, Chris Giles, Jonathan Wheatley and Valentina Romei (25/2/22)
- Ukraine conflict raises the possibility of stagflation
Financial Times, The Editorial Board (25/2/22)
- Five ways the Ukraine war could push up prices
BBC News, Laura Jones (5/3/22)
- Jason Furman cautions against reading too much into the initial market reactions to Russia’s invasion
interest.co.nz, Jason Furman (26/2/22)
- Putin’s war promises to crush the global economy with inflation and much slower growth
Market Watch, Nouriel Roubini (25/2/22)
- Roubini: 6 Financial, Economic Risks of Russia-Ukraine War
ThinkAdvisor, Janet Levaux (25/2/22)
- Fed tightening plans now contending with war, possible oil shock
Reuters, Howard Schneider and Jonnelle Marte (24/2/22)
- The invasion of Ukraine changed everything for Wall Street
CNN, Julia Horowitz (27/2/22)
- Why the Russian invasion will have huge economic consequences for American families
CNN, Matt Egan (24/2/22)
- European gas prices soar and oil tops $105 after Russia attacks Ukraine
Financial Times, Neil Hume, Emiko Terazono and Tom Wilson (24/2/22)
- Five essential commodities that will be hit by war in Ukraine
The Conversation, Sarah Schiffling and Nikolaos Valantasis Kanellos (24/2/22)
- Ukraine: ‘I’m surprised the oil price hasn’t hit US$130 a barrel yet’ – energy trading expert Q&A
The Conversation, Adi Imsirovic (25/2/22)
- Ukraine crisis: Warning UK energy bills could top £3,000 a year
BBC News, Michael Race (25/2/22)
- Putin’s energy shock: The economic realities of invasion
BBC News, Faisal Islam (25/2/22)
- Fears of UK food and fuel prices rising due to war
BBC News, Oliver Smith & Michael Race (26/2/22)
- Ukraine conflict: What is Swift and why is banning Russia so significant?
BBC News, Russell Hotten (27/2/22)
- Ukraine conflict: How reliant is Europe on Russia for oil and gas?
BBC News, Jake Horton & Daniele Palumbo (25/2/22)
- Ukraine crisis complicates ECB’s path to higher rates
Reuters, Francesco Canepa and Balazs Koranyi (24/2/22)
- Russia and the West are moving towards all out economic war
Al Jazeera, Maximilian Hess (24/2/22)
Questions
- If there is a negative supply shock, what will determine the size of the resulting increase in the price level and the rate of inflation over the next one or two years?
- How may expectations affect (a) the size of the increase in the price level; (b) future prices of gas and oil?
- Why did stock markets rise on the day after the invasion of Ukraine?
- Argue the case for and against relaxing monetary policy and delaying tax rises in the light of the economic consequences of the war in Ukraine.
Many important economic changes have occurred over the past two years and many have occurred in the past two months. Almost all economic events create winners and losers and that is no different for the Russian economy and the Russian population.
There is an interesting article plus videos on the BBC News website (see link below), which consider some of the economic events that, directly or indirectly, have had an impact on Russia: the fall in oil prices; the conflict between Russia and the Ukraine; the fall in the value of the rouble (see chart); the sanctions imposed by the West.
Clearly there are some very large links between events, but an interesting question concerns the impact they have had on the everyday Russian consumer and business. Economic growth in 
Russia has been adversely affected and estimates suggest that the economy will shrink further over the coming year. Oil and gas prices have declined significantly and while this is good news for many consumers across the world, it brings much sadder tidings for an economy, such as Russia, that is so dependent on oil exports.
However, is there a bright side to the sanctions or the falling currency? The BBC News article considers the winners and losers in Russia, including families struggling to feed their families following spending cuts and businesses benefiting from less competition.
Russia’s economic turmoil: nightmare or opportunity? BBC News, Olga Ivshina and Oleg Bodyrev (5/2/15)
Questions
- Why has the rouble fallen in value? Use a demand and supply diagram to illustrate this.
- What does a cheap rouble mean for exporters and importers within Russia and within countries such as the UK or US?
- One of the businesses described in the article explain how the sanctions have helped. What is the explanation and can the effects be seen as being in the consumer’s interest?
- Oil prices have fallen significantly over the past few months. Why is this so detrimental to Russia?
- What is the link between the exchange rate and inflation?
